Classic Pen Company Case
MBA 628: Managerial Accounting
Instructor: Dr. Juan J. Segovia
1/27/2014
Genevieve Lavigeur
Kenny Summerville
Leo Perez Saba
Mohamed Shadi
Simon Foucher
BMA 628
Case 3 – Classic Pen Company
Problem Definition
 Classic Pen Company has an ineffective product costing system.
Quantitative Analysis
 Exhibit 1 shows how overhead costs related to indirect labour and computer systems
have been sub-divided based on activities performed. This provides a more precise
cost division than pooling these cost items into single categories. Fringe benefits have
been excluded from the cost allocation and instead a 40% premium on all labour costs
was included. This reduces the number of costs items and therefore simplifies the
company’s understanding of cost drivers.
 Exhibit 2 demonstrates the total overhead costs per cost driver. This will provide
information on cost per units of the various cost drivers.
 Exhibit 3 shows the unit product costs for each product category using ABC costing.
This method charges to each product its actual consumption of indirect costs, which
is more effective than allocating costs based on plant-wide averages.
 Exhibit 4 shows a revised income statement based on ABC overhead allocation.
Contrary to Ms. Dempsey’s previous statement, PURPLE and RED pens actually
generate operating losses.
 Exhibit 5 demonstrates the percentage revenue of each product category. PURPLE
and RED pens only account for 10% of total revenues, a figure that is not that
significant compared to the amount of resources they consume to produce.
Qualitative Analysis
 The company is making product development decisions based on inaccurate
information.
 Increasing the price of PURPLE and RED pens is not a viable option for the
company, as pen prices are sold based on a fixed premium driven by market.
 With total annual revenues of $150K, the company most likely cannot sustain a sales
manager, a controller, a manufacturing manager, manufacturing and maintenance
staff on the payroll.
 Focusing on price rather than profitability and/or revenue potential is not an effective
sales strategy if the company’s goal is to maximize profits.
 Since physical changeovers account for 40% of indirect labor, color diversification is
costly, especially if volumes are low.
Recommendation
 Adopt ABC costing in order to assess the profitability of products more effectively.
 Stop taking orders for RED and PURPLE pens, and once orders are fulfilled, color
productions should be discontinued.
 Make longer production runs of BLACK and BLUE to minimize physical
changeovers and thereby reduce associated overheads.
2
BMA 628
Case 3 – Classic Pen Company
Exhibits
Exhibit 1: Plant wide overhead cost allocation based on various activities.
Expense Category
Ind. Labor - Scheduling Runs
Ind. Labor - Changeover
Ind. Labor - Records
Fringe Benefits
Computer Systems /Run
Computer Systems - Records
Machinery
Maintenance
Energy
TOTAL
Expense
$10,000.00
$8,000.00
$2,000.00
$16,000.00
$8,000.00
$2,000.00
$8,000.00
$4,000.00
$2,000.00
$60,000.00
Cost Driver
# Runs
Setup Time
# of Products
Total Labor H
# Runs
# Products
Machine H
Machine H
Machine H
Exhibit 2: Total overhead cost per cost driver
# Runs
Ind. Labor - Scheduling Runs
40% Frings on ind. Labor
Computer Systems /Run
Total OH cost / # Runs
Setup Time
Ind. Labor - Cangeover
40% Frings on ind. Labor
Total OH / Setup H
Machine Hour
Machinery
Maintenance
Energy
Total OH / Machine Hour
# Products
Ind. Labor - Records
40% Frings on ind. Labor
Computer Systems - Records
Total OH / # Products
$66.67
$26.67
$53.33
$146.67
$15.21
$6.08
$21.29
$0.80
$0.40
$0.20
$1.40
$500.00
$200.00
$500.00
$1,200.00
3
Total Cost Driver
$ / unit driver
150
$66.67
526
$15.21
4
$500.00
Add 40% on LH
150
4
10000
10000
10000
$53.33
$500.00
$0.80
$0.40
$0.20
Case 3 – Classic Pen Company
BMA 628
Exhibit 3: Overhead costs allocated based on resource utilization
BLUE
# Runs
Cost / Run
Total Run OH
# Setup Hours
Cost / H
Total Setup OH
# Machine Hour
Cost / Machine H
Total Machine H OH
# Product
Cost / Product
Total Product OH
DL
Fringe on DL
Total OH
$
$
BLACK
RED
PURPLE
TOTAL OH
50
$146.67
$7,333
50
$146.67
$7,333
38
$146.67
$5,573
12
$146.67
$1,760
$22,000
200
21.29
4,259
50
21.29
1,065
228
21.29
4,855
48
21.29
1,022
$11,200
$
$
$
$
$
$
5000
$1.40
$7,000
4000
$1.40
$5,600
900
$1.40
$1,260
100
$1.40
$140
$14,000
1
$1,200.00
$1,200.00
1
$1,200.00
$1,200.00
1
$1,200.00
$1,200.00
1
$1,200.00
$1,200.00
$4,800
$10,000
$4,000
$23,791.89
$8,000
$3,200
$18,397.97
$1,800
$720
$13,608.09
$200
$80
$4,202.05
$8,000
$60,000
Exhibit 4: Revised income statement
Sales
BLUE
$75,000
BLACK
$60,000
RED
$13,950
PURPLE
$1,650
TOTAL
$150,600
Materials
Direct Labor
Total Direct COGS
$25,000
$10,000
$35,000
$20,000
$8,000
$28,000
$4,680
$1,800
$6,480
$550
$200
$750
$50,230
$20,000
$70,230
Indirect OH costs
$23,792
$18,398
$13,608
$4,202
$60,000
Total Costs
$58,792
$46,398
$20,088
$4,952
$130,230
Operating Income
$16,208
$13,602
-$6,138
-$3,302
$20,370
4
BMA 628
Case 3 – Classic Pen Company
Exhibit 5: Revenue % per pen color
$ Sales
% Total Sales
BLUE
$75,000
50%
BLACK
$60,000
40%
5
RED
$13,950
9%
PURPLE
$1,650
1%
TOTAL
$150,600
100%